FINANCIAL INSTITUTIONS ADVISORY & FINANCIAL REGULATORY
CLIENT PUBLICATION
21 December 2011
.......................................................................................................................................................................................
Twice as MAD: Legislative Proposals to Amend the
European Regulation of Market Abuse
.......................................................................................................................................................................................
The European Commission has published its legislative proposal to revise the
Market Abuse Directive. The proposal takes the form of a directive and a
regulation. Firms and individuals will need to prepare for the expanded scope of
the new measures, which seek to close gaps in European market regulation and
bolster the powers of national regulators. This memorandum summarises the
main proposals.
Introduction
The Market Abuse Directive (“MAD”)1 came into force in early 2003 and introduced a harmonised framework within the
European Union to regulate insider dealing (trading while in possession of inside information) and market manipulation
(behaviours such as spreading false information and conducting trades which skew prices). These practices collectively
constitute “market abuse”.
The legislative proposals of the European Commission (the “Commission”) are intended to address various gaps and
perceived weaknesses in the regulation of market abuse, acknowledging the need to reflect technological developments
and the fragmentation of trading. The review of MAD is one of a number of current EU initiatives aimed at
strengthening financial regulation, and will sit alongside the proposed European Market Infrastructure Regulation
(“EMIR”),2 which proposes mandatory clearing and reporting of over-the-counter (“OTC”) derivatives; the proposed
Short Selling Regulation, which restricts certain types of short selling and credit default swaps; the Regulation on Energy
Market Integrity and Transparency (“REMIT”), which establishes rules prohibiting abusive practices affecting the
wholesale energy markets in the European Union; and proposed amendments3 to the Markets in Financial Instruments
Directive (“MiFID”), which, among other things, will widen the regulatory perimeter for financial institutions and users
of financial services. 4
1
Directive 2003/6/EC.
2
See Shearman & Sterling publications “OTC Derivatives Regulation and Extraterritoriality” dated 10 October 2011 and “A New Panorama for the Clearing and
Recording of Over-the-Counter Derivatives in Europe: the Proposed European Market Infrastructure Regulation” dated 29 September 2010.
3
See European Commission, Proposal for a Directive of the European Parliament and the Council on Markets in Financial Instruments repealing Directive 2004/39/EC
of the European Parliament and of the Council (COM (2011) 656/4) (recast).
4
See Shearman & Sterling Publication “Proposed Regulation of EU Emissions Allowances as Financial Instruments” dated 8 November 2011.
Under the Commission’s proposals, the amended market abuse regime will address the following:

market abusive behaviour in relation to products traded on a wider range of platforms, venues and even some
OTC trading;

market abusive behaviour in relation to spot commodity trading;

cross-market manipulation;

emissions trading;

ambiguities in the original MAD;

attempts at abusive behaviour; and

enhanced enforcement powers.
The Legislative Proposal and Relationship with Other Initiatives
The Commission proposes to replace MAD with a market abuse regulation (“MAR”) and to create a new directive to
introduce mandatory criminal sanctions for market abuse (“CSMAD”).5
An EU regulation, unlike a directive, is directly applicable in the law of member states and so does not require national
implementing legislation. The MAR proposal aims to ensure a harmonised set of rules across the EU and to address
certain divergences in the national legislative measures employed to implement MAD. For example, there are currently
variations in member states’ application and understanding of “accepted market practices”, a recognised defence under
MAD,6 their approach to permitting delays in disclosing inside information to the market7 and other practices endorsed
by particular national regulators.8 Under MAR, administrative and regulatory sanctions will also apply for market abuse
which will ensure regulatory convergence in this respect too.
CSMAD seeks to harmonise criminal sanctions for market abuse across the EU by providing for a minimum set of
penalties for market abuse offences. The proposals do not aim to prevent market abuse from also being treated as an
administrative offence.
These proposals were released on the same day as the proposals to revise MiFID.9 Both measures complement one
another in terms of a significant widening of the business trading practices and instruments now falling within their
scope and in bringing in stricter and more extensive regulations. In particular, both initiatives:

will regulate instruments traded on a Multilateral Trading Facility (“MTF”) or an Organised Trading Facility
(“OTF”) — the new MiFID II category of trading venue — as well as certain types of OTC trading;

broaden the scope of regulation to regulate the trading of emissions allowances; and

reflect certain concerns associated with algorithmic or high frequency trading (“HFT”).
5
European Commission, Proposals for a regulation on Market Abuse and Proposals for a directive on criminal sanctions for Market Abuse, 20 October 2011.
6
For example, MAD Article 1.1.
7
MAD, Article 6.2.
8
See, for example, ESME Report “Market Abuse EU Legal Framework and its Implementation by Member States: a First Evaluation”, June 2007, p. 8.
9
See Shearman & Sterling Publication “A Changing Landscape: The MiFID II Legislative Proposal” dated 20 October 2011.
2
Both MAR and MiFID II also include various proposed measures aimed at easing the regulatory burden on SMEs by
removing some of the barriers arising from cross-border compliance costs for smaller firms.10
Current UK Regime
The UK currently imposes both administrative and criminal sanctions for various types of market abusive behaviour.
The UK retained certain provisions11 from the pre-FSMA UK market abuse regime (hence it is “super-equivalent” to
MAD or has “gold-plated” it). This has resulted in a wider definition of market abuse in the UK than that which exists in
many other member states. For example, in addition to the existing species of abusive behaviour (insider dealing,
market manipulation, dissemination of rumours), the UK characterises behaviour that “is likely to be regarded by a
regular user of the market as a failure on the part of the person concerned to observe the standard of behaviour
reasonably expected of a person in his position in relation to the market”12 as market abuse. The UK government has
announced that it will end the practice of “gold-plating” future EU directives.13 The current gold-plated provisions have
been extended until 31 December 2014, to reflect the existing policy of aligning any changes with the outcome of the
MAD review,14 but are expected to fall away once MAR has been implemented. This raises questions as to how certain
supposedly questionable behaviour which principally falls foul of the UK specific offences — such as the pre-hedging or
“icing” of convertible bond issuances15 — will be treated.
Developments and Expansion in MAR
MAR will further develop and expand the market abuse regime across the EU. It seeks to provide for a “single European
rulebook”, with updated definitions of key terms, and clarifications as to the obligations of firms in relation to the
detection and prevention of market abuse. There will also be an expansion of scope to cover trading venues, trading
practices and cross-market manipulative strategies not covered by MAD. The legislation will also introduce, in
conjunction with the Commission’s MiFID II proposals, specific disclosure requirements for inside information related
to emissions trading.
Expanded Definition: Insider Dealing
MAR makes small changes to the definition of “inside information” contained in MAD. This definition is key not only to
the offences but to the disclosure regime for issuers. The definition retains the concept that “inside information” must
have a significant effect on price if made public. Market users must also expect to receive such information in
accordance with market practice. Similar wording to both new provisions is included in the UK’s current definition of
market abuse,16 and in the MAD implementing directive.17 A separate definition applies to commodity derivatives (see
below).
10
Commission Staff Working Paper: Impact Assessment (“Impact Assessment”), p. 35.
11
Now FSMA, Sections 118(4) - misuse of information and 118(8) - misleading behaviour and market distortion.
12
FSMA, Section 118(8).
13
BIS Press release, 15 December 2010.
14
Financial Services and Markets Act 2000 (Market Abuse) Regulations 2011 (SI 2011/2928).
15
FSA’s Consultation paper CP149, “Market abuse - Pre-hedging convertible and exchangeable bond issues”, July 2002.
16
FSMA, Sections 118(4) and (6).
17
Directive 2003/124/EC, Article 1.2.
3
MAR also creates a new category of inside information, defined as information which is not generally available but which
would be relevant to a reasonable investor.18 Such information appears to be intended to include matters such as the
state of contract negotiations, provisional contract terms, marketing conditions and provisional terms of placements.19
Trading on the basis of such information would therefore be prohibited. However, this sort of information will not
always require disclosure. There will continue to be an exception20 to the obligation on issuers to disclose information to
the market where the information is insufficiently precise.21
As regards the mental element of the market abuse offences, the new proposal does not address the effect of the
controversial decision in the Spector Photo case,22 in which the European Court of Justice circumscribed the
requirement to demonstrate intention on the part of someone trading on the basis of inside information. It was held that
MAD did not provide that prohibited transactions be carried out “with full knowledge of the facts” but merely prohibited
insiders from using inside information when entering into market transactions. The ECJ noted that not every primary
insider in possession of inside information who enters into a market transaction would be caught and that it is only the
use of information that goes against the purpose of MAD that constitutes insider dealing.23 One interpretation of the
decision is that where a person holds inside information, there is a presumption of an intention to base trading decisions
on that information. Another interpretation is that the judgment merely restates the point that MAD does not require
proof by the regulator of a person’s intention to prove insider dealing. Following the Spector Photo case, the FSA
amended the Code of Market Conduct in the FSA Handbook to state that it is not necessary to provide evidence of a
person’s intention in order to prove insider dealing.24 Under the UK’s primary legislation, an offence is committed where
dealings are made “on the basis of” inside information, which is generally thought to be a similar, if not identical,
concept. The FSA did not consider that UK legislation needed amending following the ECJ decision.25 Nevertheless, any
perceived discrepancy between the UK and EU mental element of the test will be eliminated once MAR enters into force,
since the regulation will be directly applicable in the UK.
Expanded Definition: Market Manipulation
MAR extends the obligation on market operators to adopt structural provisions aimed at preventing and detecting
market manipulation to operators of all MTFs and OTFs, in line with MiFID II.26 MAR is intended to curtail market
manipulation by prohibiting all behaviour that will secure prices at an “abnormal or artificial level”,27 as well as attempts
18
MAR, Article 6.1(e).
19
MAR, recital 14.
20
MAR, Article 12.3.
21
MAR, Article 12.3 and recital 14.
22
C-45/08 Spector Photo Group NV v Commissie voor het Bank, Financie-en Assurantiewezen [2009] EUECJ.
23
See Shearman & Sterling publication “The Spector Photo case: ECJ rules on the interpretation of the Market Abuse Directive” dated 5 February 2010.
24
The FSA consulted on the amendment in October 2010. The amendment came into force on 6 March 2011.
25
The proposed amendments to FSMA following the UK government’s plans to overhaul the financial regulatory framework in the UK do not include any amendments to
the relevant provision.
26
MiFID, Article 11.1.
27
MAR, Article 8.1(a).
4
to manipulate markets (whilst only attempted insider dealing is prohibited under MAD), whether or not successful.28
Cancelling or amending an order while in possession of inside information will also be prohibited under MAR.29
Expanded Obligation: Disclosure of Inside Information
MAD permits issuers to delay public disclosure of inside information so as not to prejudice legitimate interests, provided
that such delay would not be likely to mislead the public and provided also that the issuer is able to ensure the
confidentiality of that information.30 MAR maintains this flexibility, but in addition, requires issuers, once the
information is finally disclosed, to inform national regulators of their decision to delay disclosure.31 National regulators
would therefore be systematically informed of delayed disclosure and could impose sanctions for non-compliance with
MAR. MAR also empowers national regulators to delay disclosure of systemically important inside information when it
is in the public interest to do so.32
Despite strong opposition to the proposals from institutions such as the CBI, which argued that there was “[no] evidence
within the UK regulated markets that an obligation to notify the competent authority in these circumstances would
improve the overall level of compliance with the obligation to disclose inside information”,33 the Commission expects
that the combination of these provisions will enhance the certainty of the disclosure rules, and ensure the smooth and
fair operation of European markets. This requirement could lead to significant changes to how M&A deals are notified to
regulators.
Expanded Scope: Closing Gaps in the Regulation of New Markets and New Practices
Currently, a financial instrument which is traded only OTC or on an MTF, and is not traded on a regulated market, is not
covered by MAD. The UK’s market abuse offence has historically been wider, applying to some MTFs and to trading in
instruments which, although not themselves traded on-exchange, are “related investments”, whose price or value
depends on that of a qualifying investment.
MAR extends the scope of the EU market abuse framework to any financial instrument admitted to trading on an MTF
or OTF,34 as well as to any related financial instruments traded OTC which can have an effect on an underlying market
that is covered by MAR.35 Under MAR, only those instruments exclusively traded OTC, and which are not related
derivative financial instruments to those otherwise covered by MAR, would remain unregulated.36 Market participants
may find it difficult in practice to identify which instruments are traded on an MTF or OTF, particularly since some
platforms admit instruments by class. The London Stock Exchange includes large numbers of foreign issuers in its
28
MAR, Article 8.2.
29
MAR, Article 7.1.
30
MAD, Article 6.2.
31
MAR, Article 12.4.
32
MAR, Article 12.5.
33
European Commission Consultation on Market Abuse Directive, Response from Confederation of British Industry, August 2010, p. 3.
34
MAR, Article 2.1(b).
35
MAR, Article 2.3.
36
Impact Assessment, p. 67.
5
international order book, for example. The proposed expanded scope may therefore lead to a lack of legal certainty as to
when behaviour is covered by MAR and defensive market behaviour. It is hoped that market participants can identify
the instruments that are subject to MAR.
Certain technologically advanced trading systems, such as broker crossing networks and swap execution facilities are not
currently expressly addressed by MAD,37 although the definition of market manipulation in MAD is broad and capable of
applying to abusive behaviour regardless of the trading medium employed.38 Specific examples of strategies used by
algorithmic and high frequency traders are now identified in MAR as falling within the prohibition against market
manipulation.39 The Commission intends that this, and future identification of further abusive strategies, will ensure a
consistent approach in monitoring and enforcement by national regulators.
Expanded Scope: Commodity and Commodity Derivatives
MAR will introduce more comprehensive market abuse regulation to the derivatives markets. MAR will work in
conjunction with REMIT (discussed below) to curtail certain cross-market manipulative strategies that have been
perceived to fall outside the MAD regime, even though they can have an impact on other markets. For example, a person
could stock-pile physical assets, enter into a futures contract in relation to those assets, and then make physical delivery
of the stock-piled assets to satisfy the derivative contract. The Commission wishes to ensure that non-financial activities
would also be covered.40
Market abuse in relation to wholesale energy markets is restricted by REMIT,41 which from January 2012 introduces a
new market abuse and monitoring regime for the European wholesale energy markets, including spot markets, but not
financial instruments that are regulated by MAD.42 This regulation will work in combination with MAR, which aligns the
definition of inside information in relation to commodity derivatives with that applicable to other financial instruments43
and also extends the definition of market manipulation to cover abusive squeezes, whereby a trader seeks to secure a
dominant position over the supply of or demand for a financial instrument or related spot commodity contract, with the
effect of manipulating the financial market.44
37
In particular, the Commission is concerned about quote stuffing (a tactic of quickly entering and withdrawing large orders in an attempt to flood the market with quotes
that competitors have to process, thus slowing down order management by other traders), spoofing (a technique for manipulating prices on securities markets by
entering and withdrawing orders that the trader never intended to execute) and layering (a directional type of spoofing, whereby a trader enters several orders to
improve the price of a trade in the opposite direction).
38
Proposal for a regulation, p. 8.
39
MAR, Article 8.3(c).
40
MAD, Article 2 renders illegal only the distortion of the price of financial instruments, rather than derivatives trading which distorts the prices of physical markets.
41
REMIT, Articles 3 and 5.
42
REMIT, Article 1.2.
43
MAR, Article 6.
44
MAR, Article 8.3.
6
Expanded Scope: Emissions Allowances
The regulation of emissions allowances under MAR and MiFID II is discussed in a separate client note.45 In addition to
the applicability of the market abuse offences to these instruments, persons engaging in transactions involving the
trading of emissions allowances would, under certain circumstances, also have a duty to publicly disclose inside
information (or face committing market abuse if they did not do so). The duty to disclose inside information would
effectively only be placed on the very largest emitters, whose physical activities could significantly affect the market price
of allowances.
Expanding Powers: Bolstering National Regulators
It is thought by the Commission that the MAD regime is weakened by (i) a lack of data on suspicious transactions in OTC
derivatives, which it says have the potential to be used for insider dealing and market manipulation, and (ii) a lack of
access for regulators to data traffic in some member states. MAR expands the powers of national regulators to obtain
such data,46 and closes the information gap for the spot commodity markets.47 National regulators will have the power to
requisition existing telephone and other data traffic records held by a telecommunication operator, or by an investment
firm, where a reasonable suspicion exists that such records may be relevant to proving insider dealing or market
manipulation.48 Co-operation between the European Securities and Markets Authority (“ESMA”) and other national
regulators will be enhanced.
MAR also introduces several common principles to strengthen and harmonise civil sanctions imposed by national
regulators: (1) fines should not be less than the profit made from market abuse where this can be determined; (2) the
maximum fine should not be less than twice the value of any such profit;49 (3) for natural persons, the maximum fine
should not be less than €5 million;50 and (4) for non-natural persons it should not be less than 10% of annual turnover.51
Member states will be free to impose sanctions which exceed these limits, but may not allow lower sanctions.52
Other powers53 include the power to suspend the trading of a relevant financial instrument, to impose a temporary ban
on any member of an investment firm’s organisational body or on any other responsible natural person exercising
functions in an investment firm, and to impose the criminal sanctions introduced by CSMAD (as discussed below).
Criminal Offences and Sanctions
CSMAD requires member states to establish criminal offences for individuals for insider dealing and market
manipulation.54 Attempts to commit insider dealing and market manipulation will also be criminal offences under
45
See Shearman & Sterling Publication “Proposed Regulation of EU Emissions Allowances as Financial Instruments” dated 8 November 2011.
46
MAR, Chapter 4.
47
MAR, Article 17.2(c).
48
MAR, Article 17.2(f).
49
MAR, Article 26.1(k).
50
MAR, Article 26.1(l).
51
MAR, Article 26.1(m).
52
MAR, Article 26.2.
53
MAR, Article 26.1.
7
CSMAD, as will inciting or aiding and abetting. This contrasts with MAD, which requires member states to adopt noncriminal sanctions but allows a discretion to impose criminal sanctions.55
The UK imposes wide-ranging criminal sanctions for market abuse:56 insider dealing, market manipulation and
misleading statements have long been criminal offences in the UK. These were supplemented by the administrative
market abuse offences created by FSMA.57 Although the slightly lower standard of proof in the administrative regime
may make it easier to secure a conviction, the FSA has, in recent years, been committed to using its criminal prosecution
powers where possible to further its policy of “credible deterrence” and it has obtained a number of criminal convictions.
Such an approach is likely to continue, though based on the new guidance on fines set out in CSMAD.
The criminal offences will encompass all financial instruments, regardless of whether or not the instrument is admitted
to trading on a trading venue. In addition, it will be explicitly stated that a legal person (such as a corporation) may be
held liable for any of these offences if the offence is committed for its benefit by a person who holds a “leading position”
at the firm. This provision has the potential to capture a broad range of senior employees who are authorised to make
decisions on behalf of a firm.
Next Steps
Both of the drafts of MAR and CSMAD will now be passed to the European Parliament and the Council for the final text
to be agreed and, ultimately, adopted. On adoption, MAR will enter into force after two years. Member states will also
have two years to transpose CSMAD into national law. As a result of it being a regulation, MAR will not require national
implementing legislation. In the UK, amendments to the Section 118 of FSMA provisions, which have contained the UK
market abuse offence since before the first MAD was adopted will likely have to be made. It is anticipated that the
process will take three years in total, and the UK has extended the present ‘gold-plated’ provisions of Section 118 of
FSMA on that basis.
Conclusion and Impact in the UK
Although the MAR and CSMAD proposals in many respects tighten up EU laws to reflect matters covered in the UK
regime but overlooked in the first MAD, there are significant extensions to the existing ambit of market abuse law. Some
of the changes are logical solutions to addressing obvious gaps in the existing regime. However, when taken in
conjunction with other Commission proposals, in particular REMIT, EMIR and MiFID II, these initiatives manifest a
clear shift in the EU’s approach to regulation, to harmonise regulation and regulatory powers in relation to financial and
commodity markets across Europe. Concerns have been expressed in the UK that the loss of national discretion may
weaken the supervisory and enforcement capabilities of national regulators. Firms and market participants generally are
likely to face increased compliance responsibilities and must, in due course, make significant preparations for transition
to the new regime.
54
CSMAD, Articles 3 and 4.
55
MAD, Article 14.
56
Part V of the Criminal Justice Act 1993 (CJA) and FSMA, Section 397.
57
FSMA, Section 118.
8
This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased
to provide additional details or advice about specific situations if desired.
If you wish to receive more information on the topics covered in this publication, you may contact your regular Shearman & Sterling contact
person or any of the following:
Barnabas W.B. Reynolds
London
+44.20.7655.5528
barney.reynolds@shearman.com
Tobia Croff
Milan
+39.02.0064.1509
tcroff@shearman.com
Hans Diekmann
Düsseldorf
+49.211.17888818
hdiekmann@shearman.com
Thomas Donegan
London
+44.20.7655.5566
thomas.donegan@shearman.com
Pierre-Nicolas Ferrand
Paris
+33.153897177
pferrand@shearman.com
Katja Kaulamo
Frankfurt
+49.69.97111719
katja.kaulamo@shearman.com
Roger Kiem
Frankfurt
+49.69.97111672
rkiem@shearman.com
Bertrand Sénéchal
Paris
+ 33.153897095
bsenechal@shearman.com
Bill Murdie
London
+ 44.20.7655.5149
bill.murdie@shearman.com
Azad Ali
London
+44.20.7655.5659
azad.ali@shearman.com
John Adams
London
+44.20.7655.5740
john.adams@shearman.com
Aatif Ahmad
London
+44.20.7655.5120
aatif.ahmad@shearman.com
Christine Ballantyne
London
+44.20.7655.5750
christine.ballantyne@shearman.com
Mark Dawson
London
+44.20.7655.5609
mark.dawson@shearman.com
Anna Doyle
London
+44.20.7655.5978
anna.doyle@shearman.com
Nina Garnham
London
+44.20.7655.5118
nina.garnham@shearman.com
Mak Judge
London
+44.20.7655.5182
mak.judge@shearman.com
BROADGATE WEST | 9 APPOLD STREET | LONDON | EC2A 2AP | WWW.SHEARMAN.COM
Copyright © 2011 Shearman & Sterling LLP. Shearman & Sterling LLP is a limited liability partnership organized under the laws of the State of Delaware, with an affiliated limited
liability partnership organized for the practice of law in the United Kingdom and Italy and an affiliated partnership organized for the practice of law in Hong Kong.
9